Capturing capex opportunities

Having covered all of our other major investment themes for this year in our recent blogs, it’s now the turn of what we believe could be widespread capex growth and its possible effects.

Company management teams were reluctant to undertake major capital expenditure projects while the investment climate was uncertain. Despite low interest rates, higher asset prices and weak corporate confidence proved to be too much of a deterrent. However, we see this trend reversing, and expect a number of significant catalysts to prompt growth in global capex.

Chief among them is a material shift in the global economic backdrop - growth has been gaining momentum, and there is now a largely synchronised recovery across the world. Companies can now focus on replenishing their productive capacity; safe in knowledge there should be demand.

Differing dynamics

However, the dynamics differ across the globe. The drive for higher capex looks to be strongest in the US, where tax reform should galvanise greater commitment to capital spending programmes. There are now increased tax incentives for them to do so; they can now expense all their capital expenditure for five years, with interest deductions of up to 30% of EBITDA (earnings before interest, depreciation and amortisation).

Also, the steeper-than-expected levy – 15.5% – on the trillions of dollars held overseas by US companies is likely to prompt a rapid repatriation of offshore cash. Once back in the US, it may go towards share buybacks or dividend payouts, but some, we believe, will find its way into capital expenditure programmes. Lower corporation tax rates will also give companies more money to spend.

Business confidence figures are strong, particularly among small businesses, a key ingredient for capex and employment growth. At the same time, strong profitability and cashflow generation for US companies will also remain supportive of capex trends. Companies have a lot of cash to put into motion.

There is push as well as pull. US assets are ageing. Statistics from the Bureau of Economic Analysis showed the average age of all US fixed assets to be 22.8 years in 2015. This is the oldest they have been since records began back in 1925. We believe this will prompt management teams to accelerate their investment efforts or risk losing competitiveness.

Advances in Asia and Europe

We see capex accelerating across Asia and Europe as well, albeit for different reasons. In Japan, for example, the authorities are putting incentives in place for certain types of capital expenditure. The country needs more automation to counter the ageing of its population, which is prompting significant investment in robotics. In China, there is increasing investment in machinery, after a period of notable wage inflation. There too, companies recognise the need to automate in order to retain the global competitiveness of their products.

In Europe, companies have built up significant cash reserves after years of caution over the economic and political climate. The eurozone economy now has considerable momentum. Indeed, all member countries enjoyed accelerating growth last year. This has boosted corporate confidence and encouraged companies to put cash to work.

Sector standouts

There are a number of sectors likely to be beneficiaries of the growth in capex. The most obvious is technology. Not only have companies held back investment, there are now new trends in which to participate. For example, software-as-a-service helps them manage technology costs more efficiently, while the move to the cloud has real advantages for security and cost. There are competitive and productivity pressures for companies. At the same time, technology stocks tend to perform well at this more mature stage of the economic cycle.

Other sectors that may benefit include the banking sector. Rising yields and greater borrowing requirements could help margins improve. We believe the oil sector may also be at the heart of additional capex spending. A more stable oil price is creating the incentive to invest in productive capacity and this is likely to come through over the next 12 months.

There are risks to this scenario. The most pressing would be a sudden resurgence in inflation and a resulting rise in interest rates. Borrowing costs are already moving higher, and the tax reform bill in the US placed some limits on the deductibility of interest rate payments. This would curtail investments funded via debt increases. However, many companies are sitting on large cash piles and as such, are relatively insensitive to interest rates.

Barring these potential detractors, we believe corporate capital expenditure may surprise to the upside over the next 12 months. This will add further support to equity markets, particularly in certain sectors, so it remains one of our key investment themes for the year ahead.

Where will Capex and tax reform take you?

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